EXANTE Macro Quarterly Insights

By Renée Friedman, PhD

Welcome to our fourth quarter 2021 Macro Quarterly Insights. We will be taking a look at what has happened in the world of global economics and finance over the past quarter and what events and actions may impact markets in the next few months.

A short global overview 

The fourth quarter of 2021 saw some global markets reach new highs and despite the rise of the Omicron variant, the S&P 500 was supported by strong corporate earnings and was up 10.65% in Q4 2021, while the Stoxx 600 was up 7.25%, and the FTSE 100 ended the quarter up 4.21%. Overall gains were robust despite a weaker November, during which fears over rising cases of the Omicron variant of Covid-19 and the speed of the Federal Reserve’s asset tapering had weighed heavily on market sentiment. By year-end, these worries had largely subsided, while data such as the December flash manufacturing PMIs in the US (57.8), the eurozone (58.0) and the UK (57.6) continue to indicate that corporate earnings are likely to be positive.

The fourth quarter started with a continuation of the volatility that we saw at the end of the third quarter due to rising inflation and disagreements between central banks about just how transitory it was. Although supply chain and shipping bottlenecks are slowly being cleared, there remains concerns that we will see growing policy divergence as global economies recover at very different paces into 2022. 

As inflation went past central banks 2% targets, global markets were focused on when and how fast the US Fed would begin its taper of asset purchases and when they may consider a rate rise. The market rallied with the renomination of Chair Jerome Powell, and various comments by Fed board members, following the release of December’s headline CPI of 7%, the highest since July 1982, that the Fed will take further action if needed, have led to the market pricing in at least 3 rate hikes in 2022. This resulted in 10 year bonds reaching yields not seen in years. 

In Europe equities made gains in Q4, as a focus on strong corporate profits largely offset worries over the Omicron variant although some countries did introduce lockdown measures and mandatory vaccination. As in the US worries emerged over inflation due to supply chain bottlenecks and volatile gas prices. Although annual inflation in the Eurozone is expected to have come in at 5.0% in December 2021, up from 4.9% in November according to a flash estimate from Eurostat, well below US levels, the ECB, in its December meeting, insisted that inflation was still transitory despite admitting it may not reach target levels until early 2023. In December it agreed to continue its purchasing policies for as long as necessary to reinforce the accommodative impact of its policy rates. However, the pressure is piling on as such an extended period of above target inflation may start to feed into wages. President LaGarde had also agreed that  “... If price pressures feed through into higher-than-anticipated wage rises or the economy returns more quickly to full capacity, inflation could turn out to be higher."

In the UK equities rose over the quarter. The lack of a lockdown did help some sectors such as banking regain some ground, but the rise in cases toward the very end of the year has hurt some sectors, notably leisure and travel. The Bank of England confused markets in November by not raising rates although strongly hinting it would do so. The Bank of England’s monetary policy committee finally raised its policy rate by 0.15 percentage points to 0.25% in December.

In Asia ex-Japan, equity markets were down 1.2% over the quarter. There was a broad market sell-off once the Omicron variant emerged as investors thought it would once again close down those economies and once again lead to supply problems. China was the worst-performing market in the index in the quarter. 

Investor sentiment towards Emerging markets (EM) was negatively affected by the rapid rate cuts by the Turkish central bank, largely forced by President Erdogan. The Turkish central bank lowered its policy rate by a total of 400bps to 14%, despite rapidly rising inflation which reached 21.3% year-on-year in November. The lira hit new lows against the USD during Q4, at one point, losing more than 50% of its value against the USD. In response, President Erdogan announced a scheme to compensate savers for lira weakness, in an effort to reduce the use of US dollars. 

EM equities declined 1.2% in Q4 (down 2.5% over the year) in reaction to a stronger U.S. dollar and  continuing supply chain disruptions, the moderation in metal prices and the spread of Omicron and  re-imposition of some Covid-19 restrictions. However, as central banks in some EMs continued to raise rates, local currency bond yields rose. EM currency performance was mixed, influenced by a higher dollar rather than the prospect of higher interest rates.

In Latin America, Brazil was the weakest market in Q4 as inflation continued to rise above target and the central bank responded with further interest rate hikes; the policy rate was increased by 300bps during the quarter. There were also growing concerns over the fiscal outlook and political uncertainty ahead of October 2022’s presidential election. This will likely pit former Leftist President Luiz Inácio Lula da Silva, who was imprisoned as part of a corruption scandal, against the country's far-right President Jair Bolsonaroalso, who downplayed, to devastating effect, the risks of Covid to the population. The election of leftist leader Gabriel Boric as president of Chile may mean changes to the budget, which would likely occur in April 2022 and limit the expected drop in public spending. 

What to keep in mind for Q1 2022

Although the Omicron variant is still affecting global economies, the fact that it seems to be less deadly and that far more people globally have been vaccinated, with a growing number in developed markets receiving booster shots, has shifted concerns to inflation, the number and rate of interest rate changes, and if the growth story that started last year, will continue in all markets or if some, like the UK, will fall behind. There are still some potential geopolitical risks that investors need to keep in mind that may have some significant currency effects, be equity market dampeners, affect bond markets, and influence the price of the full range of commodities, e.g, oil, gold, silver, copper, lithium, cobalt, aluminium, etc. and other alternative asset classes like cryptocurrencies.

On 17 January is the Bank of Japan meeting. Markets will be looking to see if it does indeed decide to begin to scale back its asset purchase programme as previously announced in December. Expectations have held down the yen to less than ¥110 per US dollar since late September.

The US Fed will meet on 25 January. The expectation is that the speed of the taper will be increased with the first rate rise to take place in March. The language will be closely watched to see what the conditions will be for the Fed to consider multiple rate hikes in 2022. 

This will be followed by the ECB policy meeting on 2 February. Although the ECB agreed to reduce its pandemic emergency purchase programme by March, it said it would continue its very accommodative policy stance (ramping up bond purchases under the Asset Purchase Programme (APP): €40 billion of bonds under the APP in the second quarter, €30 billion in the third quarter, then from October onwards, purchases will be maintained at €20 billion for as long as it deemed necessary). It still insisted that inflation would moderate in the medium term and that it would not be raising rates in 2022. However, inflation in the Euro area reached a record 5% in December and is running at an even faster pace in Germany. This means that new Bundesbank President Joachim Nagel, much like his predecessor Jens Wiedmann, will try to put pressure on the ECB to at least remove some accommodative measures.  Markets still don’t agree with ECB action either and are much more hawkish on a potential rate hike this year although this will be very dependent on whether wage data starts to suggest a definitive change in inflation expectations.

And on 3 February it will be the turn of the Bank of England. After disappointing markets in November and then raising rates in December, markets are still expecting a rate rise in February as inflation is likely to continue to rise into 2022, possibly peaking around 6% due to the surge in electricity prices, while Omicron's damage to the economy  is likely to be lower than previous Covid variants. 

4-20 February 2022 Winter Olympics. Scheduled to take place in Beijing, China. Several nations, including the US and the UK, have declared a diplomatic boycott of the games in response to China’s alleged human rights abuses in Xinjiang against the Uigars, for activities against Taiwan and wider geopolitical tensions with the Chinese Government.

14-18 February: 55th Session of the Intergovernmental Panel on Climate Change (IPCC 55). This meeting, rescheduled from September 2021, will provide an updated assessment of the global trajectory on climate change. The results will likely put increasing pressure on governments and corporations to commit to Net Zero emission targets and/or carbon reduction targets. 

On 10 March all eyes will again turn to the ECB to see how quickly they may reduce their purchase programme as inflation is still likely to be well above target. 

On 15 March the US Federal Reserve will meet again to decide if a rate hike, the first since 2018, is appropriate. Much will depend not just on the rate of inflation but also the state of the labour market including information on wages or other inflationary expectation measures.

On 17 March the Bank of England will meet again to discuss whether a rate rise is warranted.

And finally, on 27 March 2022 there is the Hong Kong Chief Executive Election. This will be the first Chief Executive election since Beijing’s controversial “patriots-only” rule came into place, which forces all candidates to be screened by a government committee. Incumbent Carrie Lam, who has overseen the suppression of democracy in Hong Kong,  is likely to run for her second term.

The re-emergence of geopolitical risk

Although global economies were largely able to weather the COVID crisis without physical conflict, the risks of such conflicts and incidences of domestic civil unrest are likely to be higher than anticipated by markets in 2022.  In fact the World Economic Forum, in its global Risks Perception Survey 2021-2022,  found that  social cohesion is the fourth identified highest risk factor over the next ten years and geoeconomic confrontation the tenth. 

These results should not be surprising news. We have seen the growing tensions in the Taiwan strait as China has sought to exert its military prowess. The various back and forth between China, Taiwan, the US, Australia and the EU has worsened over the past year in particular with the US strengthening its alliances in the region with the Australia-UK-US security pact. The Beijing winter olympics, will yet again provide an opportunity for other issues beyond concerns about human rights, to come to the forefront. 

There are also growing tensions between NATO members and Russia as it remains unclear about its full intentions in Ukraine after it amassed troops near the border. Over 2021 Russia, under the guise of Gazprom which effectively, through its pipelines, affects gas prices in Europe’s biggest economy, Germany as well as in Austria and the Netherlands. Russian President Vladimir Putin was accused by many Western commentators as using higher gas prices to force the European Union into approving the Nord Stream 2 pipeline between the North Sea and Germany. Putin refuted these claims, instead blaming the crisis on the unwillingness or inability of European energy companies to pump enough gas themselves and for having inadequate storage facilities. 

Markets  were taken aback in early January 2022 by the civilian protests that erupted in Kazakhstan due to surging liquefied petroleum gas (LPG) prices, which then became bloody clashes between the security forces and civilians as protesters voiced their anger at ongoing social and economic disparities in the country. It ended with a Russian military intervention and the killing of dozens of anti-government demonstrators. The unexpected event resulted in internet access being cut and led to a drop in cryptocurrencies prices as the hashrate dropped. Kazakhstan is the world’s second-largest center for bitcoin mining after the United States, according to the Cambridge Centre for Alternative Finance As of August 2021, Kazakhstan was, according to Fortune magazine, hosting 18% of global bitcoin mining.

And geopolitical risk isn’t just in the emerging markets or border regions: elections in Italy, France, Portugal, Hungary and Sweden will put pressure on EU institutions and the Euro as there is potential for euro-skeptics gaining power in France and Italy. Although some countries, particularly the highly indebted countries of the Eurozone, benefited from the creation of the European Union's Recovery Fund which enabled joint borrowing on a scale not possible in previous crises, there is still the risk that there will be nation specific civil protests if action isn’t taken by EU institutions to combat inflation and rising social inequalities. 

In Sweden the equity market may experience disruption if the Social Democratic-led government wins and pushes through more reforms including a cap on profits for publicly funded and privately run firms while Hungary may find itself under increasing pressure from the EU if it continues to ignore EU laws and if current President Viktor Orban refuses to surrender the presidency should he lose the election in April. 

Markets should also keep an eye out for growing tensions in negotiations between the UK and the EU over the Northern Ireland Protocol (NIP), a compromise intended to keep an open land border and closed customs union. If trade blockages increase due to disagreements around the NIP,, despite supply constraints falling over the course of 2022, there are significant risks of a trade war, which could also hit financial markets as the EU may seek to impose new rules about EU financial institutions using the supply of financial services in the City of London.

And political  tensions are likely to lead to more civil unrest in the US as Republicans refuse to take responsibility for the civil unrest on 6 January 2020 that led to multiple deaths. President Biden is coming under increasing criticism, with poll approval coming in at only the high to mid 30 percentage points. His ability to get legislation passed, including the “build back better bill”, his response to protests in 2021, will only deepen the Democratic party malaise into the November midterm elections. 

So, just when we thought the world would become a safer place in 2022 with the introduction of new coronavirus treatments, greater vaccination rates and the return to “normal life,” newer (and older) risks (re)emerge.

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